What Are Self-Insured Employers?

When insurance premiums skyrocket, some employers decide to self-insure. This process is often regulated by state governments, and each state sets its own guidelines for self-insurance. Health care is one type of risk that employers may choose to self-insure against. Understanding the process is the first step in determining whether a self-insurance program is right for your company.

Risk

Insurance uses the collected contributions of many individuals to transfer and manage risk among those individuals contributing to a "pool" of money. These individuals are often referred to as insured individuals, while the pool is often called a "risk pool." In the insurance industry, this risk must be insurable; it must be defined and measurable; the loss has to be due to chance; the loss must be predictable; the loss can't be catastrophic; the exposure to loss has to be large; and the loss exposure being insured must be selected randomly. If these conditions are not met, then there is no basis for insurance. For example, if the exposure to loss isn't large enough, there won't be enough insured individuals to pay for claims that arise. It will also be hard to predict the probability of loss, since there won't be enough data about the risk off loss to make assessing risk statistically significant.

Concept

A self-insured employer is one who does not transfer the risk of loss away from the company. Instead, he retains this risk. Insurance works by spreading out risk, but its implementation is often accomplished by transferring this risk to an insurance company. The insurance company has capital reserves which are far greater than most companies can manage to keep, and it specializes in spreading out risk among all of its other policyholders. By retaining the risk, the employer takes on the job of an insurance company in addition to fulfilling its traditional role in whatever industry in which it operates. For example, an employer retaining health care risk retains some or all of the risk involved with insuring his employees.

Implementation

The employer needs to set aside funds to cover the risk. Often, state regulators require special capital reserves for self-insured employers. These reserves serve the same purpose as insurance company reserves. They provide financial stability to the insurance fund and ensure the employer can pay claims as they arise. Employers are then free to process and pay or decline health insurance claims for its employees according to its own standards.

Consideration

While retaining risk may sound less expensive than paying for outside insurance, the savings an employer envisions may never materialize. If the employer isn't experienced in risk management or capital reserves fall because of excessive claims, the self-insurance fund could be depleted rather quickly. Additional administrative staff is also needed to manage the insurance fund, the additional administrative paperwork and the claims process. If these costs exceed the costs of buying insurance from a traditional insurance provider, then the employer would be better off purchasing the insurance instead of retaining the risk.

References

• "Life & Health Insurance, License Exam Manual"; Dearborn Financial; 2004
• "Practicing Financial Planning for Professionals"; Sid Mittra, et al.; 2007